Debt including contingent liabilities rose about 13 percent
in the six months through June, based on figures in a report by
the National Audit Office, posted on its website yesterday. That
followed a 48 percent increase over the previous two years.

China’s borrowing spree in recent years has evoked
comparisons to debt surges that tipped Asian nations into crisis
in the late 1990s and preceded Japan’s lost decades. The audit
result adds pressure for Xi, yesterday named head of a Communist
Party leading group for reform, to repair a fiscal system that
starves local governments of tax revenue.

“It is a very sizable build-up and it’s the kind of build-up that is not sustainable,” said Louis Kuijs, chief China
economist at Royal Bank of Scotland Group Plc in Hong Kong, who
previously worked at the World Bank. “It’s expanding at much
too rapid a rate.”

The Shanghai Composite Index rose 0.1 percent as of 10:01
a.m. local time. The gauge has fallen more than 7 percent this
year on concern an economic slowdown and higher money-market
rates will weigh on corporate profits.

The 17.9 trillion yuan total includes 4.3 trillion yuan of
contingent liabilities, where local governments wouldn’t legally
be obliged to make repayments, the audit office said. The study
covered 62,215 government agencies, more than double the number
in the previous report, published in 2011.

‘Potential Risks’

“China’s government-debt risks are under control in
general, but there are potential risks at some places,” the
audit office said.

China’s local governments are responsible for 80 percent of
spending while getting about 40 percent of tax revenue,
according to the World Bank. Regional governments set up more
than 10,000 local financing units to fund construction projects
after they were barred from directly issuing bonds.

Dariusz Kowalczyk, senior economist and strategist at
Credit Agricole CIB in Hong Kong, said that the numbers in the
latest audit were “manageable.” Wang Tao, chief China
economist at UBS AG in Hong Kong, echoed that view, while adding
that the pace of accumulation of debt in recent years has been
“too fast and is not sustainable.”

Japan’s Fate

Avoiding a fate akin to Japan’s growth collapse of the
1990s hinges on Chinese officials’ ability to reduce debt and
shift policy, JPMorgan Chase & Co. said in a report this year.

China’s leaders pledged this month to tackle local-government debt “as an important task.” Local governments will
be able to sell bonds to fund construction and officials will be
rated on measures including borrowing levels, the party said
last month, after a meeting to chart economic policy for coming
years.

Policy makers need to put a reduced emphasis on economic-growth targets, shift some spending requirements from central to
local governments, and boost local revenues, according to Wang,
of UBS.

The audit-office report showed 10.9 trillion yuan of direct
local-government debt as of June, with 22.9 percent of that
amount due in the second half of this year. The direct local
borrowing mainly related to municipal and county-level
governments, which accounted for 44.5 percent and 36.4 percent
of the total respectively. Provincial-level debt was 16.3
percent.

Credit Guarantees

Beside direct debt and contingent liabilities, the 17.9
trillion yuan total included credit guaranteed by local
authorities, which amounted to 2.7 trillion yuan.

In September, Finance Minister Lou Jiwei called the scale
of local-government debt controllable and said the risk of
default was “not great.”

The audit report showed the total debt for central and
local governments was 30.3 trillion yuan at the end of June. Of
19.1 trillion yuan of direct central and local debt owing at the
end of 2012, 5.38 percent was overdue, according to the audit
office.